TARP Watchdog: Stress Tests Relied On Too Rosy A Scenario

WASHINGTON — A government test of whether 19 major banks could survive a further downturn in the economy may have relied on too rosy a scenario and should be repeated, independent investigators say.

In a report released Tuesday, the Congressional Oversight Panel for the government's $700 billion financial rescue effort found that the Federal Reserve used a "conservative and reasonable" approach to assessing the health of the nation's biggest banks.

But, the panel added, the Fed's worst-case scenario does not go far enough. For example, the "stress tests" conducted by the Fed were based on the 2009 unemployment rate average of 8.9 percent. Unemployment in May climbed to 9.4 percent.

"While no one should gainsay the potentially positive results of the tests, it would be equally unwise to think that those results reflect a diagnosis of all of the potential weaknesses or create a necessarily sufficient buffer against future reverses for the banking system," the panel wrote.

Asked about the findings of the oversight board, Treasury Secretary Timothy Geithner defended the stress tests, saying they were rigorous and used projected loss estimates for the banks that were worse than any two-year period during the Great Depression.

Geithner told a Senate Appropriations subcommittee that the stress tests had been "very carefully designed" and had played an important role in restoring confidence in the system.

Elizabeth Warren, the Harvard University law professor who heads the panel, told lawmakers on Tuesday that the Fed should release more details about how it conducted the tests.

"Without this information, it is not possible for anyone to replicate the tests to determine how robust they are or to vary the assumptions to see whether different projections might yield very different results," Warren told the Joint Economic Committee.

Last month, the Fed found that 10 of the 19 banks needed additional capital. Bank of America, Citigroup and Wells Fargo are among the banks told to boost capital by a total of $75 billion to cover potential losses.

Fed officials said Monday that plans submitted by those banks, if implemented, would be enough to help them survive a deeper recession.

The Congressional Oversight Panel says that additional capital held by the banks should not be interpreted as an end to the financial crisis.

The panel recommended that the Fed repeat stress testing so long as banks continue to hold large amounts of bad debt on their books. The panel also suggests that banks be required to run their own internal stress tests and share those results with federal regulators.

Last fall, the Treasury Department created the $700 billion Troubled Asset Relief Program to encourage banks to start lending again amid the darkest days of the financial crisis.

Some of the banks that received the aid now want to start paying it back. On Tuesday, the Treasury Department announced that it had approved 10 banks to repay $68 billion.

Congressional Republicans this week pressed the administration to use the money to pay down the national debt, instead of holding on to it for future potential bailouts.

Republican Rep. Jeb Hensarling of Texas introduced legislation that calls for shutting down TARP payments by the end of the year.

"TARP is increasingly not being a vehicle for economic stability and taxpayer protection, but is evolving into a $700 billion revolving slush fund that the administration can use to advance economic, social and political agenda items far and apart from what TARP was ever designed to do," Hensarling told reporters.